Martin Kronicle

I just came across a paper by Paul Krugman on the economic realities we face. Mutual fund companies and the televangelists are mostly bullish given the market comeback since the March lows of 2009.

Disagree with me? Well, as long as you have money invested or at risk, you must be bullish – otherwise it would not make much logical nor emotional sense to remain committed.

No one will care more about your money that you.

Read Professor Krugman’s paper Crises

Your sense of self-control manifests itself into your risk management guidelines. This is true regardless of whether you trade with systematized set of rules or you are a discretionary trader.

According to a recent Boston Globe article by Kevin Lewis, “One way to enhance self-control is to avoid tempting situations. The irony, according to a recent study, is that people who think they have more self-control allow themselves to get into more tempting situations and, as a result, are more likely to give in to temptation.”

Lewis continued, “For example,…smokers who were led to believe that they had superior self-control were more willing to keep a proscribed cigarette in their proximity while watching the movie “Coffee and Cigarettes,” and, as a result, they were more likely to smoke it. Likewise, smokers who were trying to quit and who also felt they had high self-control were less likely to have abstained four months later, on account of not being diligent enough in avoiding temptation.”

This is very provocative and it got me thinking about trading. After you liquidate a position, do you keep the ticker on your screen? If you’ve lost money on the offsetting trade, do you feel compelled to make money back with that specific security?

That is not a financial concern, that is emotional (ego) concern and it illustrates very well why I believe that even intermediate and advanced traders need a way to stay in check with their emotions. It’s helpful to keep a journal to record your thoughts and be brutally honest with yourself. Yoga and meditation can get you to a state where you can get more clear with yourself.

Write things down and review your notes over time. You’ll find that you might not suffer from selective memory this way and you’ll have some evidence of emotional growth. That, or you’ll be horrified by what you write.

So by the time we’re done spending an estimated $3 – $5 trillion in costs for the war, the United States is a no-show in any major oil deal struck with Iraq.

This pretty much sums up government intervention and regulation: Apply rhetoric liberally.

Great viewing on PBS for traders (and everyone) tonight on PBS with This Emotional Life. If you’ve just begun your trading career, and you’ve heard about certain men’s groups, yoga, or meditation, you’ll like this show.

Most of trading is emotional. Become more self-aware.

I’ve seen/heard the term “portfolio heat” many times. What is that exactly in relation to trading? Does it have anything to do with individual bet sizing?

Yes, think of it as the sum total of the risk you are taking over your entire portfolio including both long and short positions.

For example, if you have 4 trades on (either long or short) and you are risking 2% on each, you could say that your “portfolio heat” is 8%. If you have 10 positions @ 1%, you have 10% portfolio heat. If you have 26 positions with 0.50% risk each, you’re looking at 13% portfolio heat.

Risk here is defined as the risk to total capital (as of right now, marked to market). You calculate that as the (distance between your entry and exit) multiplied by (# contracts). You are never playing with the market’s money. Once you have unrealized gains, it’s your job to keep them as best you can.

Once you have your trading rules solidified, you can calculate what the optimum level of portfolio heat is for your systematized rules. You might find that your model has high expectancy, but the results are too volatile to market. Then you go back to the drawing board and cut individual risk per trade, what is sometimes referred to as bet size.

The level of heat you are comfortable with might not be marketable for public funds. Most allocators are looking for great risk-adjusted returns, as opposed to anything over 50% net of fees for example – something that would indicate more times than not that the trader has a high portfolio heat number. (See Staggering Growth).

Portfolio heat is tied to your temperament and personality type. If you are a risk lover, you’ll have a high heat %. The converse is true to more conservative traders. That is why I believe that self-awareness and emotional intelligence are the most important things a trader can and should learn. The math here can be taught to anyone who knows algebra.

Where it’s important is that as you evolve in your trading career and you move towards handling public funds, you’ll likely evolve to having a constant % for portfolio heat. You can set up a rule such that no new trades are entered neither long nor short until an exiting position is offset (profitably or not).